ST Engineering - UOB Kay Hian 2021-03-24: Potentially The Largest M&A In STE’s History


ST Engineering - Potentially The Largest M&A In STE’s History

  • ST Engineering (SGX:S63)’s bid for Cubic Corporation’s transportation system payments business would provide synergy to its existing capabilities and enhance its reach. However, ST Engineering has not disclosed whether it will be taking on US$0.85b in debt and the eventual divestment price of the defence business to Blackstone.
  • For now, we estimate that ST Engineering could take up at least US$2b in debt to fund the acquisition, which is likely to stretch its balance sheet.
  • Maintain HOLD on ST Engineering with a target price of S$4.00.

ST Engineering makes an unsolicited bid for Cubic Corporation in the US with an offer of US$76/share, amounting to US$2.41b.

  • In Feb 21, Cubic Corporation (NYSE: CUB) received a US$2.8b offer from Veritas Capital and Evergreen Coast Capital for US$70/share along with net debt valued at US$578m. ST Engineering has not disclosed if it would make an offer on outstanding net debt. See ST Engineering's announcement dated 23-Mar-2021.
  • Cubic Corporation operates in two business segments:
    • Cubic Mission and Performance Solutions (CMPS) and
    • Cubic Transportation Systems (CTS).
  • If ST Engineering is successful in its offer, it will immediately divest CMPS, which is the defence business to the Blackstone Group. Cubic Corporation recorded a loss of US$3.2m in FY20. The CTS segment accounts for 57% of revenue and adjusted EBITDA margin amounted to 15.9% in FY20.
  • Overall, the acquisition price translates into P/EBITDA multiple of 15.2x and trailing P/B of 2.5x. As at its last closing price, Cubic Corporation trades at a FY20 EV/adjusted EBITDA multiple of 20.5x.

Final acquisition cost will be dependent on valuation of CMPS.

  • At this stage, it is unclear if Blackstone would assume Cubic’s net debt of US$0.85b as part of the purchase consideration with ST Engineering or if it would be split equally. If Blackstone assumes Cubic’s net debt and ST Engineering manages to divest CMPS at current group EV/EBITDA of 20.5x, ST Engineering’s acquisition cost could drop to S$2.0b, while net gearing could rise to 1.3x. The acquisition will be funded entirely via debt and ST Engineering could tap into US$4.25b in Medium Term Notes, which last had an annual funding cost of 1.5%. (US$750m at 1.5% p.a.).

Cubic Transportation Systems (CTS)’s value proposition.

  • Cubic Transportation Systems (CTS) is the world’s leading fare collection system provider with a greater than 60% share of the public transport digital mobility payment systems in the US, UK and Australia. It serves 41m passengers daily with S$16b in revenue generated via its payment systems (CTS receives a fixed fee that is not proportional to the revenue generated). The adoption of a digital public payment system is still in infancy stage in the US, with representation only in a few large key cities.
  • CTS has registered a 13% revenue CAGR from 2017-20, while adjusted EBITDA has risen by 40% CAGR.
  • Operationally, CTS is focusing on 3 broad areas:
    1. Account-based ticketing system, which will allow users to consolidate all transport ticketing into a single account and pay monthly.
    2. Cloud-based system, which will lower costs for transit authorities and allow for multi-modal usage across cities and countries.
    3. Mobility as a service (Maas) digital platform, which will allow it to earn to scale up and earn a fee based on increased market penetration.

Scope for substantial synergy and scale but ST Engineering would be stretching its balance sheet.

  • There is little doubt that CTS would complement ST Engineering’s own smart mobility business and it will also give ST Engineering access to a platform business to earn recurrent revenue. However, we are unsure of the degree of adoption in Asia, given the entrenched positions of current operators.
  • There is also a substantial uncertainty on the assumption of debt, which could add to the eventual purchase price. Without this information, we are unable to access the degree of earnings accretion, if ST Engineering is successful in its bid.
  • In addition, we fear that ST Engineering would be stretching its balance sheet if it takes on US$2b in debt.

Maintain HOLD

K Ajith UOB Kay Hian Research | 2021-03-24
SGX Stock Analyst Report HOLD MAINTAIN HOLD 4.00 SAME 4.00